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TAKE CHARGE OF YOUR MONEY Good debt vs. bad debt

Posted in Personal Finance, Tips by Erineus on February 3, 2009

(This is part of Take Charge of Your Money , a partnership between INQUIRER.net and Citibank to help readers handle their personal finances well.)

Question: I’m thinking of taking steps to improve my family’s life this 2009. For starters, we’d like to buy a house so we can stop renting. It would also be good if we can get a car so it won’t be hard to get around with my family–a wife and two small kids. To do all these, I’m hoping to get a loan from the bank. Is this good or bad, considering the state of the world economy? I don’t like having debts to pay, but if I don’t avail of a loan, it would take me forever to save up for a house and a car. – Joseph

Answer: Most people who buy cars and homes for their families do not have the cash saved up to pay off these purchases right away. If they did, they would be millionaires and part of the upper crust of society. Almost all home buyers and new car owners avail of loans which will allow them to enjoy a new home and a car now and amortize the cost of buying them over a number of years.

Although you don’t like going into debt, this may be one time when it would be good to go into debt. There is such a thing as good debt and bad debt.

Good debt is when you avail of a loan to buy an asset that would appreciate over time or will give you good value or use over the years. Examples of good debt include availing of a loan to buy a house or fund a business that would generate income for you.

Bad debt, on the other hand, is availing of a loan that would be used to purchase something that would depreciate or decrease in value over time. This will cost you more over the years.

Debts have a cost attached to them. You have to pay for the cost of borrowing, which is interest. And when you miss a payment, you would also have to pay other charges including penalties, depending on what’s covered in your loan contract.

Debts are a great responsibility. If you default on a loan, your credit history will be affected, which may disqualify you from taking another loan in the future. This is why one should think twice about going into debt. If you can, take only good debt.

If you are serious about availing of a loan, heed our tips to make the most of it:
1. When choosing a home, consider its location. It should have the potential to appreciate in value over time. Some indicators of good location and appreciating value include proximity to schools, shopping malls, business districts, and commercial areas. Visit the location first before committing to buy a home.
2. Think of ways to maximize the use of the asset you’re buying. For instance, you can rent out the property if your family will not use it as a residence, or rent out one room to a boarder. If you are getting a car, consider carpooling so as to lower your gasoline cost.
3. Shop around for the best terms before signing on the dotted line. Go to several banks and financing companies and compare rates and other terms. Generally, in-house financing offered by real estate companies and car companies are the most expensive. Choose the one that offers the best.
4. Find ways to lower your cost of borrowing. Check out loans available with the Social Security System, Government Service Insurance System, and PAG-IBIG Fund. If you are buying a car, consider trading in your old one to lower the cost of purchasing a new car. It may even be wiser to buy a one-year-old car than a brand new one. It will be cheaper, yet still give you good mileage.
5. Always read the fine print before signing documents. Read about penalties, defaults, and the like. Find out if there are penalties for prepayments. If none, pay off the loan faster if you can to save on interest expense.
6. Safeguard loan documents. Keep them in a safe place but make sure your spouse knows where these can be located.

A debt can be a good tool to secure your financial future. Go into it only after careful thought and manage it well.

(INQUIRER.net and Citibank invite readers to ask questions regarding financial matters. Send your questions to personal_finance@inquirer.net or comment through our personal finance blog called MoneySmarts )

*Disclaimer: Readers are solely responsible for their own investment decisions and should thus conduct their own research and due diligence and obtain professional advice. INQUIRER.net will not be liable for any loss or damage caused by a reader’s reliance on information obtained from our web site. INQUIRER.net receives no compensation of any kind from companies or industries or funds that are mentioned here.

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First Posted 16:45:00 01/13/2009


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